Copyright © 2000 Addison Wesley Longman Slide #15-1 Chapter Fifteen THE BANKING FIRM AND BANK MANAGEMENT

Copyright © 2000 Addison Wesley Longman Slide #15-1

Chapter Fifteen

THE BANKING FIRM AND BANK MANAGEMENT


The Bank Balance Sheet

有利息或不付息包括銀行持有之 currency 及存在央行的存款

Secondary reserve

FF market

Discount loanFF marketRP agreementLoans from BHCEurodollar

Loan loss reserve 為 bank capital 之重要組成

Negotiable CD有次級市場流動性高，安全性高通常買者為大企業或其他銀行

Cash items


Bank Operation

T-account Analysis: Deposit of $100 cash into First National Bank

Assets Liabilities Vault Cash $100 Checkable Deposits + $100 (=Reserves)


Bank OperationDeposit of $100 check First National Bank

Assets Liabilities Cash items in + $100 Checkable Deposits + $100

process of collection

First National Bank Second National Bank

Assets Liabilities Assets Liabilities

Reserves Deposits Reserves Deposits

+ $100 + $100 - $100 - $100

Conclusion: When bank receives deposits, reserves by equal amount; when bank loses deposits, reserves by equal amount

First National 會將 check 轉存到它在 Fed 開的存款帳戶∴ Fed 會從 Second National 收到現金

此時 First National Bank 應只會保留 $10 作 required reserve ，其餘 $90 作 Loan 出去，以賺取較高利潤


Principles of Bank Management1. Liquidity management

2. Asset management

A. Managing credit risk

B. Managing interest-rate risk

3. Liability management

4. Managing capital adequacy

Liquidity Management Reserve requirement = 10%, Excess reserves = $10 million

Assets Liabilities

Reserves $20 million Deposits $100 million

Loans $80 million Bank Capital $ 10 million

Securities $10 million

Deposit outflow


Deposit outflow of $10 million

Assets Liabilities

Reserves $10 million Deposits $ 90 million



With 10% reserve requirement, bank still has excess reserves of $1 million: no changes needed in balance sheet

Principles of Bank Management


Liquidity ManagementNo excess reserves

Assets Liabilities

Reserves $10 million Deposits $100 million



Deposit outflow of $ 10 million Assets Liabilities

Reserves $ 0 million Deposits $ 90 million



With 10% reserve requirement, bank has $9 million reserve shortfall


1. Borrow from other banks or corporations

Assets Liabilities


Loans $90 million Borrowings $ 9 million

Securities $10 million Bank Capital $ 10 million

2. Sell securities Assets Liabilities


Loans $ 90 million Bank Capital $ 10 million

Securities $ 1 million

Liquidity ManagementFederal Fund Market or issue negotiable CD, or Eurodollar Deposit or RP agreement


Liquidity Management3. Borrow from Fed Assets Liabilities

Reserves $ 9 million Deposits $90 million

Loans $90 million Discount Loans $ 9 million

Securities $10 million Bank Capital $10 million

4. Call in or sell off loans Assets Liabilities




Conclusion: excess reserves are insurance againstabove 4 costs from deposit outflows


Asset and Liability ManagementAsset Management

1. Get borrowers with low default risk, paying high interest rates

2. Buy securities with high return, low risk

3. Diversify

4. Manage liquidity to satisfy reserve requirement

Liability Management1. Important since 1960s, 由 money center bank 開始靈活的隨時找

到資金2. No longer primarily depend on deposits

3. When see loan opportunities, borrow or issue CDs to acquire funds


Capital Adequacy Management1. Bank capital is a cushion that prevents bank failure2. Higher is bank capital, lower is return on equity

ROA = Net Profits/AssetsROE = Net Profits/Equity CapitalEM = Assets/Equity CapitalROE = ROA x EMEquity Capital , EM , ROE

3. Tradeoff between safety (high capital) and ROE4. Banks also hold capital to meet capital requirements5. Strategies for Managing Capital:

A. Sell or retire stockB. Change dividends to change retained earningsC. Change asset growth

1980 年代不動產不景氣，導致銀行承受大量之呆帳損失，∴ equity capital 又加上新的自有資本管制，強制銀行要提高自有資本比率。導致 “ credit crunch”

Make more (fewer) loansBuy (Sell) securities and increase (reduce) liabilities


Off-Balance-Sheet Activities1. Fee income from

A. Foreign exchange trades for customersB. Servicing mortgage-backed securitiesC. Guarantees of debt ，如 banker’s acceptanceD. Backup lines of credit ，如 loan commitment,

depositor overdraft, privilege, NIF or RUF

2. Financial futures and options 3. Foreign exchange trading4. Interest rate swaps5. Loan sales 將 loan 的 cash stream 賣給別人

All these activities involve risk

For hedging and speculation

如 1995 Barings trader LeesonAgency problem

Asymmetric informationmoral hazardLoss $1.3billion

It’s not the only case!! 解決之道為 monitoring, internal control, risk assessment 如 VAR


Banks' Income

Statement

Off balance sheet activities


Measures of Bank Performance

ROA = Net Profits/ Assets

ROE = Net Profits/ Equity Capital

NIM = [Interest Income - Interest Expenses]/ Assets

Why? Bad loans


Financial InnovationInnovation is result of search for profits1.Response to Changes in Demand

Major change is huge increase in interest-rate risk starting in 1960s

Example: Adjustable-Rate Mortgages

2.Response to Changes in SupplyMajor change is improvement in computer technology

1. Increases ability to collect information2. Lowers transactions costs

Examples:1. Bank Credit Cards2. Electronic Banking Facilities


3.Avoidance of Existing Regulations

Regulations Behind Financial Innovation1. Reserve requirements

Tax on deposits = i x rD

2. Deposit-rate ceilings (Reg Q)As i , loophole mine to escape reserve requirement tax and deposit-rate ceilings

i 為若將準備金 loan 出去所能賺的利率rD 為存款準備率

disintermediation


Avoidance of Existing Regulations

Examples:1. Eurodollars

2. Bank Commercial Paper

3. NOW Accounts

4. ATS Accounts

5. Sweep Accounts and Overnight RPs

6. Money Market Mutual Funds

為了規避支票存款帳戶不得支付利息的規定

BHC

1960 年代 inflationidisintermediation為了規避 deposit rate ceiling 及 reserve requirement

by calling a check a “ negotiable order of withdrawal”


Profiting from Treasury Strips

YTM=10%

<10% why?Reinvestment risk

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Copyright © 2000 Addison Wesley Longman Slide #15-1 Chapter Fifteen THE BANKING FIRM AND BANK MANAGEMENT